Apr 22, 2009
Jeffrey Goldberg of The Atlantic has this
Klarman is an acolyte of Ben Graham, the original value investor. Value investors—Warren Buffett is the most famous—seek out distressed, underappreciated assets, buy them, and wait until the rest of the world realizes that they’re worth something.
“The overwhelming majority of people are comfortable with consensus, but successful investors tend to have a contrarian bent,” Klarman said over lunch one day in an empty Boston restaurant. “Successful investors like stocks better when they’re going down. When you go to a department store or a supermarket, you like to buy merchandise on sale, but it doesn’t work that way in the stock market. In the stock market, people panic when stocks are going down, so they like them less when they should like them more. When prices go down, you shouldn’t panic, but it’s hard to control your emotions when you’re overextended, when you see your net worth drop in half and you worry that you won’t have enough money to pay for your kids’ college.”
One theme of Margin of Safety is that people like me aren’t equipped to be investors. “No one knows what he’s doing unless he’s a full-time professional,” he said. “As in many professions, full-time experts have an enormous advantage. Investing is highly sophisticated and nuanced. The average person would have an incredibly hard time competing.”
On the troubles of the small investor:
He agreed with Robert Soros that the financial-services industry treats the small investor not as a client but as a source of ready cash. “The average person can’t really trust anybody. They can’t trust a broker, because the broker is interested in churning commissions. They can’t trust a mutual fund, because the mutual fund is interested in gathering a lot of assets and keeping them. And now it’s even worse because even the most sophisticated people have no idea what’s going on.”
After 15 years of pabulum, I was enjoying, in a perverse sort of way, receiving straight talk from masters of finance.
“Everybody these days is a just-in-time investor. People say, ‘I’m going to leave my money in the market as long as possible, and then pull it out of the market just before I have to write the tuition check.’ But I think we’re seeing that the day you need to pull it out of the market, the market might be down 50 percent. It’s critical not to be greedy. Avoid leverage and don’t invest money that you can’t stand to lose.”
“I haven’t leveraged myself,” I said.
He asked me if I had a mortgage. Yes. He then asked me if the amount of money I had invested in the stock market was greater than the amount I owed on my mortgage—could I liquidate what remained of my portfolio to pay off my mortgage? I could.
“So you are leveraged. Why are you keeping your money in the market?”
“It’s because you think you’re going to make more money in the market than you’re paying in interest on your mortgage.”
“Well, are you?”
“Uhh, no. But I’m getting the mortgage-interest deduction.”
“Yes, the interest is deductible. But if you had capital gains in the market, you’d pay taxes on those. In the aftermath of this financial crisis, I think everyone needs to look deep within themselves and ask how they want to live their lives. Do they want to live close to the edge, or do they want stability? In my view, people should have a year or two of living expenses in cash if possible, and they shouldn’t use leverage anywhere in their lives.”
“But if I dump my portfolio now, I make my losses real.”
“How are you going to feel if the market drops another 50 percent?”
Klarman brings up an interesting argument. I feel like when people decide they want to invest, they do not properly weigh their actions in the context of their overall financial situation. I have a feeling that many people invest simply to say that they’re invested. As a result, they usually make poor or mediocre decisions. At the very least, they end up investing money in the market when they may have been better suited by paying down debt. The kind of arbitrage practiced, where someone takes out a mortgage but invests in the market is highly risky. But I don’t think many people weigh investing in the market versus their mortgage.
Finally, Klarman’s question to ask anyone who is interested in investing:
“Here’s how to know if you have the makeup to be an investor. How would you handle the following situation? Let’s say you own a Procter & Gamble in your portfolio and the stock price goes down by half. Do you like it better? If it falls in half, do you reinvest dividends? Do you take cash out of savings to buy more? If you have the confidence to do that, then you’re an investor. If you don’t, you’re not an investor, you’re a speculator, and you shouldn’t be in the stock market in the first place.”
Be sure to read the entire article, there are excellent insights from Bill Ackman and Robert Soros among others.